Digimarc (DMRC)

Q3 2011 Earnings Call

October 25, 2011 5:00 pm ET

Executives

Bruce Davis - Chairman and Chief Executive Officer

Michael McConnell - Chief Financial Officer, Principal Accounting Officer, Executive Vice President and Treasurer

Analysts

Matthew Galinko

Andy Hargreaves - Pacific Crest Securities, Inc., Research Division

Paul Sonz - Sonz Partners

Nick Zamparelli

Kevin Hanrahan - KMH Capital Advisors

Presentation

Operator

Good afternoon and thank you for participating in today's conference call. Now, I will turn the call over to Chairman and the CEO of Digimarc, Bruce Davis. Mr. Davis, please proceed.

Bruce Davis

Thanks. Thank you and good afternoon, everyone. Welcome to our conference call. Mike McConnell, our CFO, is with me. The objectives of this call are to review and discuss the third quarter financial results, talk about significant business developments and market conditions and provide an update on our strategy and operations. This webcast will be archived in the Investor Relations section of our website.

Please note that during the course of this call, we will be making certain forward-looking statements including those regarding revenue recognition matters, results of operations, investments, initiatives and growth strategies. These statements are subject to many assumptions, risks, uncertainties and changes in circumstances. Any assumptions we offer about future performance represent a point-in-time estimate. Actual results may vary materially from those expressed or implied by such statements. We expressly disclaim any obligation to revise or update any assumptions, projections or other forward-looking statements to reflect events or circumstances that may arise after the date of this conference call. For more information about risk factors that may cause actual results to differ from expectations, please see the company's filings with the SEC, including our latest Form 10-Q.

Michael will begin by commenting on our financial results. I will then discuss our outlook and execution of strategy. Mike?

Michael McConnell

Thanks, Bruce. And good afternoon, everyone. Our quarterly profits grew by $2.1 million (sic) [$2.2 million] over last year on a $3.3 million or 63% increase on revenues. The balance sheet remains in excellent shape, with more than $30 million in cash and securities and no debt. We repurchased approximately 114,000 shares during the quarter, including 64,000 shares in the open market. And we continue investing in our growth initiatives, including building out our joint ventures with Nielsen, developing the second wave of retained patents and beginning commercialization of Digimarc Discover, all in support of our vision of enabling computers, networks and other digital devices to see, hear, understand and respond to their surroundings. In Q3, as I said revenues grew -- revenues were $8.6 million or 63% higher than the prior year, primarily reflecting increases in revenues from Intellectual Ventures and for increased services from our central bank customer. Gross margin of 80%, which is 8 points higher than the prior year and reflects a greater mix of license revenues to the total. Higher operating expenses reflect in increased investments and new product initiatives and the Verance litigation and operating profit of $1.4 million or 17% of revenues and a $700,000 capital contribution to our joint ventures with Nielsen, where our share of a net loss was also $700,000.

Bruce will now provide his comments on our outlook and execution of strategy.

Bruce Davis

Thanks, Mike. As we near the close of 2011, operating performance continues generally in line with our expectations with 2 exceptions. Federal government business development and Verance. As I noted in our last call, our long-term anti-counterfeiting program is doing fine, with revenues in defense and intelligence customers are lagging behind our expectations. I hope then that some recent contractor works and cyber security defense would ameliorate the situation in the second of the year but this doesn't happened. Although Digimarc is part of the winning team with the Vertex Corporation on a $180 million contract to provide a broad range of research and development support to the national security community, we have not yet begun the work. It is in the nature of this area of business that the causes and duration of delays can be difficult to discern. We're ready to begin work when the customer gives us the go-ahead. In the meantime, the relevant company staffed for fully and well employed and other business, so we're not suffering from any unabsorbed fixed cost. In addition to the in Vertex award, we have other defense and intelligence growth opportunity in the sales funnel, but we cannot reliably predict any outcomes at this point, particularly given all the budget challenges and the political chaos our federal government is experiencing. There were nowhere -- where the variance from our 2011 planning assumptions is beyond now dispute with Verance. Litigation is continuing. In the meantime, Verance is paying significantly less royalties that we believe are owed, without a material effect on our revenues and profits. We have prevailed in all significant court decisions so far. Verance had filed a Declaratory Judgment action against us in the U.S. District Court in Delaware on September 30, 2010, alleging the invalidity and non-infringement of 22 patents held by Digimarc and asking for the contract to be voided. The court dismissed Verance's case on jurisdictional grounds. Verance had appealed the dismissal. In December of last year, we filed through against Verance in the District Court of Oregon from breach of contract that tell them to make payments under the license agreement. The court recently denied Verance's motion to dismiss or stay the action and compel arbitration. The court also ruled that Verance breached the agreement by taking a retroactive credit of $1.8 million. Verance is disputing these rulings.

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